Filing an Extension? Here's What To Do!

It’s that time of year.  The snow has melted and the flowers are starting to bloom.  And now the tax deadline is looming and you’re just not ready to file.

Maybe this is the year that you file an extension, so let’s talk about that today.

The first thing you have to understand is that filing for an extension on IRS Form 4868 does not give you an extension of time to pay your tax liability.  If you need more time because you owe the IRS big bucks and you just don’t have the money, an extension isn’t going to help you, but more on that later.

People typically file an extension when they have business or investment interests that require more time to calculate gains and losses for the year.  Another common reason to file an extension is because you’re living outside the United States or serving in combat as a member of the armed forces (but those have special rules that we’ll talk about in a future blog).  

In order to file an extension, you have to complete your annual tax return to the extent that you have actual data available, and then use your best estimate for everything else.  The safest thing to do with regard to those best estimates is to use last year’s data, unless you know for certain that there are going to be significant changes.  In any case, filing an estimate really does require you to complete a “draft” version of your tax return and pay what you owe.

So you file the Form 4868 and send in your estimated tax payment, and then you file a complete tax return sometime before October 15^th.  But that’s for when you owe money to the IRS.  Can you use the Form 4868 to claim a refund?

Three Words: Not Bloody Likely.

Actually, it’s really just one word: No.

The IRS and most states expect you to file a return by the April 15^th deadline regardless of whether you owe a tax liability or you expect a refund. However, there are no penalties for filing late when you have a refund coming, and although the IRS will never say this out loud, if you have a refund coming, they don’t care if you never file your tax return.  They’re happy to keep your refund, thank you very much.

OK.  So that’s what you do when you need more time to file your return.  But what about when you owe the IRS thousands in tax liability but just don’t have that kind of money?  The most common response from taxpayers is to not file a return, under the mistaken impression that the IRS can’t collect the balance due until you actually file.

Wrong, wrong, and wrong!

Not only can the IRS collect from you, they’re going to collect a heck of a lot more because of the penalties-and-interest smack down you’re about to experience.  Failing to file a tax return (when there’s a balance due) results in a penalty of 5% of the balance due each month, up to 25% of the total.  So if you owe the IRS $5,000 and wait until December 31 to fess up, your Tax Liability + Penalty = $6,250.  But that’s not the end of it.

There is a monthly penalty for Failure to Pay a tax return that is separate from the Failure to File penalty.  Failure to Pay is .5% each month for as long as it takes you to file a return.  In the example above, you’d be paying an additional $25 per month, so by New Year’s Eve you’d be on the hook for an additional $200.  Now we’re up to $6,450.

Ah, but that’s not the end of it.  In addition to the penalties, the IRS also charges you interest of 4% on your balance due.  In this case, if you didn’t file and pay your return until the end of the year, the interest would be an additional $175, so your grand total would be $6,625 on a $5,000 tax liability.

The lesson?  File your tax return even if you can’t pay.  

As you can see from the example above, the biggest hit one takes is from Failure to File penalty.  The Failure to Pay penalty and the interest are small potatoes by comparison.  What’s more, the IRS will allow you to work out a payment plan that will avoid the Failure to Pay penalty altogether.  

So if you file on time and request a payment plan, all you pay is the interest, which at 4% is really pretty reasonable.  Try getting that deal from your credit card company.

Tax Filing Day is April 18^th – Don’t Forget!

After the 18th, I’m out of here for some well-deserved time off, but I’ll be back with new tax and finance topics in May.  If you have any tax questions or need assistance, you can e-mail me at jeffrey.ritchie@yahoo.com.

Thanks for reading!